Tutorial 5 Flashcards
Expected value
The value of each possible outcome times the probability of that outcome, i.e. a probability weighted average of each possible outcome.
Expected utility
The value of the utility of each possible outcome times the probability of that outcome, i.e. the probability weighted average of the utility from each possible outcome.
Fair bet
A wager with an expected value of zero.
Risk averse
Unwilling to make a fair bet.
Risk neutral
Indifferent about making a fair bet.
Risk preferring
Willing to make a fair bet.
Risk premium
The maximum amount that a risk-averse person would pay to avoid taking a risk.
Gambler’s fallacy
The mistaken belief that past events affect current, independent outcomes. More specifically, if an independent event occurred more frequently than expected in the past, then it is less likely to occur in the future and vice versa.
Hot-hand fallacy
The mistaken belief that if you “win” or “lose” several times in a row, you are either “hot” or “cold”, respectively, meaning that you think the streak is likely to continue. However, this is just pure probability as wins or losses are independent.
Overconfidence
The tendency of overestimating the probability of winning a bet.
Framing
The mistaken belief that people react the same way when given equivalent choices no matter how they are posed.
Certainty effect
Many people put excessive weight on outcomes that they consider to be certain relative to risky outcomes.
Prospect Theory
People are concerned about gains and losses - the changes in wealth - rather than the level of wealth, as in expected utility theory. People start with a reference point - a base level of wealth - and think about alternative outcomes as gains or losses relative to that reference level.
Low probability events
People overweight the low probability of good events, but underweight the low probability of bad events.
